Can we eliminate tax terrorism?

Finance Minister (FM) Nirmala Sitharaman’s hands are likely to be full with the slowing economy and the dismal job scenario. But one of the solutions to kick start the economy is to promote private investments. One reason (though not the only one) why India is considered a difficult destination for private investment is due to the hostile relationship between the tax department and the taxpayers.

The tax battles that give the tax department its bad name are mostly fought around the tax that is sought to be squeezed out of the reluctant taxpayers after significant additions are made, based on detailed scrutiny of their tax returns. This kind of “squeezed tax” accounts for less than 10 per cent of the total direct taxes collected (around Rs 99,000 crores out of the direct tax collections of Rs 11.50 trillion collected in FY 2017-18). While the taxpayer appeals, he has to pay 20 per cent of the demand. In most cases, the taxpayer wins the appeal as the increased demand does not pass judicial scrutiny.

So, most of this tax arrears are the 80 per cent of the tax that is under litigation which gets knocked off on appeal and hence, is not payable. The department itself has marked 94 per cent of all direct tax arrears as “demand difficult to recover”. In effect, all the bad blood and the bad reputation of the department comes from its attempt to collect this 10 per cent of the total tax collections, which will mostly be refunded later with interest.

The online tax information network and the implementation of Goods and Services Tax have already improved voluntary compliance to a large degree, leaving even less scope for inflated demands. Any emphasis on trying to collect taxes through this route is bound to be counterproductive and generate further ill will for the tax department. As part of a stable government that has the long term in mind, the new FM should not try this tried and tested, but failed model to improve direct tax collections.

Tax department should be given possible targets, and can’t be challenged easily. The tax department should use the vast array of online information now at its disposal. Secondly, there should be a provision for demerit points on the specific assessing officer (and his supervising Commissioner) for making “perverse additions” or imposing “perverse penalties” that are called out as such by the judicial authorities. Perverse can be very strictly defined to cover only rare cases to protect the assessment officers for bonafide decisions taken by them. The judicial authorities (starting from the income tax appellate tribunal) can opine on whether a particular addition or a penalty is perverse or not. This is likely to make the assessment officers accountable and focus on additions that are based on “data mismatch” rather than those that are based only on “legal interpretations”.

This is not a smooth transition, but has the potential to eliminate the scourge of tax terrorism and have a transformative impact on the economy without really affecting the direct tax collections except perhaps in the first year of its implementation. Can the FM bite the bullet?  

The writer is a Sebi-registered investment advisor

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